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5 Things You Should Know About Required Minimum Distributions

One key element of retirement planning is taking required minimum distributions from retirement accounts. RMD rules govern how much you must withdraw from certain retirement accounts and when you must start taking withdrawals.

As with all things retirement-related, RMD rules are complex. And there's a lot at stake. Failure to take a RMD in any given year can result in steep tax penalties.

Most tax-advantaged retirement accounts, including IRAs, 401(k)s and business-sponsored retirement plans, have RMD rules. But the rules vary from one account to another. As you're planning for retirement withdrawals, it's essential that you take these rules into account:

1. Some plans don't have RMDs until you retire. For all non-Roth IRAs, including SEP, SIMPLE and SARSEP plans, you have to start taking RMDs by April 1 of the year following the year in which you turn 70 ½. It doesn't matter whether you're retired.

But for defined-contribution plans including 401(k)s and 403(b)s you can put off taking RMDs if you're still working. This is the case unless your specific plan's rules require earlier, age-based RMDs or you own 5 percent or more of the company that runs the defined-contribution plan.

So if you plan to keep working into your 70's, you'll need to take RMDs from any non-Roth IRAs. But you can let your 401(k) or 403(b) accumulate until April 1 following the calendar year in which you retire.

2. You may get hit with two withdrawals in the same year. Once you start taking RMDs you must keep taking them every year by December 31. It's pretty straightforward once you get into the swing of it. But the first year can get a little complicated.

For instance, if you turn 70½ on June 20, 2014, you'll need to take your first RMD by April 1, 2015. But that distribution actually counts for 2014. Then, you'll have to take your 2015 RMD by December 31, 2015.

Be sure to calculate the cost in taxes. Taking two RMDs in one year could throw you into a higher tax bracket, increasing your total taxes owed. For some individuals, it's smarter to take RMDs one year at a time, even if it means taking that first withdrawal a few months before you technically must. As always, consider consulting with a tax professional before making any decisions.

3. The tax penalty for missing RMDs is hefty. Failure to take a RMD by the deadline lays on one of the heftiest U.S. tax penalties around: 50 percent. If you were required to take out a $5,000 RMD, but didn't, you'll owe the IRS $2,500. And if you miscalculate your RMD and take $1,000 less than you're supposed to, you'll owe $500.

The IRS might waive the penalty for a missed or late RMD if you were going through a personal or natural disaster, or if your financial advisor or IRA custodian gave you incorrect advice. But calculating and taking RMDs is ultimately your responsibility. Failure to meet this responsibility could cost you a serious chunk of change.

4. Excess distributions don't count for next year. Chances are likely that in some years you'll need to withdraw more than the minimum from your individual and defined-contribution accounts. Unfortunately, excess distributions in 2014 don't lower your RMDs in 2015, at least not directly.

RMDs are calculated by dividing an account's balance by an IRS-calculated life expectancy figure. So, the lower your account balance, the lower your RMD. And since excess distributions lower your account balance, they also indirectly lower next year's RMD.

5. You can skip RMDs by converting your assets to a Roth IRA. You can't take your $2,000 RMD for 2014 and roll it into another tax-deferred account or a Roth IRA. However, you can choose to convert your IRA assets to a Roth IRA at any time.

The conversion will trigger taxes, of course. But they'll no longer be subject to RMD rules. A Roth conversion requires evaluating the tax implications, expected time in retirement and even estate planning considerations. But a Roth IRA conversion in retirement isn't always the best plan, so it's wise to consult with a financial advisor if you are considering this option.

Rob Berger is an attorney and founder of the popular personal finance and investing blog, doughroller.net. He is also the editor of the Dough Roller Weekly Newsletter, a free newsletter covering all aspects of personal finance and investing, and the Dough Roller Money Podcast.